Concerns grow over Israel's loosening budget ahead of election year

JERUSALEM (Reuters) - As Israel approaches an election year, the central bank and analysts have become increasingly worried that the budget deficit is too high and gives the government no room to deal with a potential economic slowdown.

Israeli Prime Minister Benjamin Netanyahu speaks during an annual state memorial ceremony for Israel's first prime minister, David Ben Gurion, at his gravesite in Sde Boker, Israel November 14, 2018. REUTERS/Ronen Zvulun

The Bank of Israel has expressed concern that the Finance Ministry has set budget deficit targets of 2.9 percent of gross domestic product for the past two years and for 2019, arguing that level makes it hard to reduce public debt.

October data showed the deficit over the past 12 months jumping to 3.6 percent of gross domestic product from 3.35 percent in September and 2.5 percent in August, as spending has grown and tax income has slipped.

“A deficit of 2.9 percent is too high given the economy is too close to full employment,” said Karnit Flug, whose five-year term as Bank of Israel governor ended on Tuesday.

“It’s the kind of deficit that not only does not continue the decline in the debt-to-GDP ratio but may cause a slight increase.”

Flug and Finance Minister Moshe Kahlon have sparred on fiscal policies for more than three years over Kahlon’s enthusiasm for tax cuts. The central bank believes tax increases are needed to help finance higher state spending.

In past years one-time factors, such as the sale of Israeli companies, have boosted tax revenue and kept the deficit to about 2 percent. In 2018 so far there have been no such items.

“The fact that we had them in previous years doesn’t mean we will continue having them,” Flug told Reuters. She pointed to a host of spending commitments made by the governing coalition which make it tough to hold down the deficit.

The ministry expects the deficit to be between 3 and 3.3 percent of GDP this year and hopes it can stick as close as possible to a 2.9 percent target in 2019, despite an expected rise in election year spending.

After a strong start to 2018, tax revenue has started to slow of late but economic data still show solid economic growth.

“Israel’s economy is stronger than ever ... I pledge that the deficit will not deviate significantly (from the target),” Kahlon said last week.

“There is pressure from many groups in the economy, including the Bank of Israel, to raise taxes. There is no need to raise taxes.”

SLOWDOWN

If the current revenue trend continues and spending spikes, the deficit could reach 4 percent of GDP next year, said Jonathan Katz, chief economist at Leader Capital Markets.

“Being an election year, it’s really difficult to consolidate,” he said. “Kahlon said he is not going to raise taxes and it doesn’t look good to cut health and education spending.”

Katz believes an economic slowdown could start in the second half of 2019 into 2020 “and we won’t have any ammunition” since the central bank is expected to start raising rates in 2019.

“Eventually, the economy will slow down,” said Adi Brender, deputy director of the bank’s research department.

“We want to build buffers to have space so when a slowdown hits the economy fiscal policy can support the economy.”

Israel’s low deficits in recent years and a drop in the debt-to-GDP ratio to below 60 percent in 2017, compared with more than 100 percent in the early 2000s, were key factors in a sovereign ratings upgrade from Standard & Poor’s to “AA-“ in August.

Karen Vartapetov, a sovereign ratings director at S&P, was mostly upbeat over Israel’s fiscal policy, despite some deterioration, saying the longer-term outlook remained mostly positive and noting that Israel’s debt burden was falling.

“Fiscal policy is a bit loose for this stage of the economic cycle but it’s not a ratings weakness,” Vartapetov told Reuters.